Local govt bond issues to rise this year

Local government bond issuances are expected to hit a record this year as the government continues steps to stabilize infrastructure construction and spur economic growth, despite economic activity almost rebounding to the levels before the COVID-19 pandemic, experts said.

According to estimates from the National Debt Association of China and China Chengxin International Credit Rating, new local government bond issuances in the country are set to reach 4.62 trillion yuan ($714 billion) by the end of this year, with local government special-purpose bonds accounting for a substantial portion of the total. The expected amount exceeds the 4.55 trillion yuan of local government bonds that were issued last year, according to data provided by the Ministry of Finance.

This year, the funds raised via local government bonds will be used for "new infrastructure" construction, new urbanization and capital expansion for some projects via special bonds. It will help ease financial difficulties and expand leverage, according to "The Blue Book of China's Local Government Bonds".

According to the book, after China's new budget law was enacted in 2015, local government bond issuances surged and maintained a compound annual growth rate of 50.4 percent. By the end of March, outstanding local government bonds in China exceeded 26 trillion yuan, accounting for 22.17 percent of the bond market, it said.

Sun Xiaoxia, chairwoman of the National Debt Association of China and a former senior official of the Ministry of Finance, said local government bonds, as a financial instrument traded in the capital market, must follow the market rules for issuance and consider optimization of the pricing patterns. Interest rates of the bonds must reflect the diversification of credit spreads in various regions and projects, she said.

Sun called for more local government bond issuances to enrich the various types of investors and improve liquidity in the secondary market. "In the medium to long term, improving the efficiency of resource allocation, promoting high-quality and efficient economic development and fundamentally reducing the leveraging ratio are the steps needed to solve the local government debt problem and achieve sustainable development," she said.

China's bond market is already the second-largest in the world, the International Monetary Fund said in a new book called the Future of China's Bond Market. The book indicated that local government bonds account for about 20 percent of the Chinese bond market, making it the third-largest globally.

After the global financial crisis of 2008, Chinese government bonds have forged stronger links with the global financial conditions and are connected more tightly with the volatility index of the global financial market, the IMF said.

Alfred Schipke, former IMF senior resident representative for China, said the country's bond market has been included in major global indexes such as Bloomberg Barclays Global Aggregate Index, JPMorgan bond index and FTSE Russel Index, and further bond market development and opening-up could be expected during the 14th Five-Year Plan period (2021-25).

Foreign capital inflows through the bond market opening-up programs mainly flowed into government and quasi-government bonds, which have relatively higher ratings, said Zhang Longmei, former deputy resident representative of the IMF for China.

Reforms have continued despite the crisis, especially in the financial sector, and further measures to support financial liberalization could expose China to the global financial cycle even more, the IMF experts said. They said the key reforms should include harmonizing and clarifying rules, removing implicit guarantees and increasing foreign participation.

Risks for Chinese local government bonds are controllable, but there are some structural issues that need to be factored in, said Zhang Ming, deputy head of the Institute of Finance and Banking of the Chinese Academy of Social Sciences.

The leverage ratio of the government sector remains at a relatively high level, while implicit debt risks still exist for local governments. When the financing gap between local governments' fiscal revenue and expenditure expand, especially in some central and western provinces, then debt repayment pressures become prominent. Besides, debt risks should not be allowed to spill over into the banking system, said Zhang.

In the medium and long term, the central government and commercial banks are the main drivers responsible for reducing the local government debt burden, and some debt swaps and restructuring are necessary to curb the rising debt levels, he said.